Question

1. Explain the effect of different discount rates on the present value of receiving $1 in the future.  

The fourth rate is your choice: use the slider in the table to choose a discount rate you think is appropriate for the evaluation of the benefits and costs of climate change policy in the distant future.

2. Justify your choice. Is it closer to the Nordhaus or Stern proposal? Or is it higher than or lower than both?  

Answer 1

Present value (PV) is the current value of a future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows. Determining the appropriate discount rate is the key to properly valuing future cash flows, whether they be earnings or debt obligations.

KEY TAKEAWAYS

• Present value states that an amount of money today is worth more than the same amount in the future.
• In other words, present value shows that money received in the future is not worth as much as an equal amount received today.
• Unspent money today could lose value in the future by an implied annual rate due to inflation or the rate of return if the money was invested.
• Calculating present value involves assuming that a rate of return could be earned on the funds over the period.

difference in opinion between the Nordhaus and Stern camps with regards to policy (though not discount rate assumptions) has lessened. Using the latest version of the Nordhaus model, DICE-2013, Nordhaus finds an optimal initial (2015) carbon price of approximately $21 per short ton of CO2 in 2012 U.S. dollars (a near tripling from DICE-2007). Moreover, the optimal tax according to Nordhaus rises more rapidly over time as compared to DICE-2007. A tax of this amount would restrict the average global temperature increase to approximately 3 degrees Celsius above pre-industrial level